The allowance for doubtful accounts is a balance sheet account that reduces the reported amount of accounts receivable. (A change to the balance in the allowance for doubtful accounts also affects bad debt expense on the income statement.) Providing an allowance for doubtful accounts presents a more realistic picture of how much of the accounts receivable will be turning to cash. After all, a company selling products (or services) on credit to thousands of customers will likely have a few customers who will not be able to pay the full amount they owe to the company.
By recording an amount in the allowance for doubtful accounts it will also mean that the bad debt expense will be reported closer to the time of the sales–instead of waiting until the account is determined to be uncollectible. Hence, the matching principle is carried out more effectively.
The allowance account and the related bad debt expense is encouraged for financial reporting; however, it is not acceptable for income tax reporting. The Internal Revenue Service prefers that any expense for bad debts be deducted later–when an account is actually written off as uncollectible.
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